English

Etymology

Pronunciation

An overdraft occurs when withdrawals from a
bank account exceed the
available balance
which gives the account a negative balance - a person can be said
to have gone "overdrawn".

If there is a prior agreement with the account
provider for an overdraft protection plan, and the amount overdrawn
is within this authorised overdraft, then interest
is normally charged at the agreed rate. If the balance exceeds the
agreed terms, then fees may be charged and higher interest rate
might apply.

History of the Overdraft

In one instance, overdraft was
awarded in 1728 when merchant
William Hog was allowed to take out £1000, almost £65000 today,
more than he had in his account. The overdraft was awarded by
The Royal Bank of Scotland which had opened in Edinburgh the
previous year. It soon began to offer interest on money paid
in.

Reasons for overdrafts

Overdrafts occur for a variety of reasons. These
may include:

Intentional short-term loan - The account holder finds himself
short of money within a few days of payday and knowingly makes an
insufficient-funds debit. He accepts the associated fees and covers
the overdraft with his next cash or check deposit. While this may
be considered acceptable behaviour by the bank, it is not
recommended as a financially-prudent habit.

Personal lacking of organizational skills - The account holder
does a poor job at balancing his/her checkbook or keeping good
track of funds contained in the account.

Lack of Communication - In a joint checking account, the
parties do not consistently share information about checks written,
withdrawals made, or check-card purchases made, leading one to
believe that funds spent by the other are present.

ATM overdraft - In recent years, many banks and ATM's often
allow cash withdrawals despite insufficient funds to a limit. The
account holder may or may not be aware of this fact at the time of
the withdrawal. Some banks give the holder a chance to return
enough cash to the account in time in order to avoid the penalty,
while others do not. If the ATM is off the modem line for some
reason and still functions, it may not know the account holder's
available balance and allow a large overdraft. In this case, if the
overdraft cannot be covered in time, the bank will sue or press
criminal charges.

Temporary Hold - Some funds in the account have been placed on
hold by the bank. This may be due to Regulation CC (which governs
putting holds on large dollar amount checks) or due to individual
bank policies. The funds may not be immediately available and lead
to overdraft fees.

Unexpected electronic withdrawals - At some point in the past,
possibly months ago, the account holder authorized electronic
withdrawals by a business. If the business makes a debit without
warning the accountholder, it may cause an overdraft or leave
insufficient funds to cover a subsequent withdrawal or debit. This
could occur in good faith of both parties if the electronic
withdrawal in question is made legally possible by terms "buried"
in the contract. The
debit could also have been made as a result of a wage garnishment,
an offset claim for a taxing agency or a credit account or
overdraft with another account with the same bank, or a
direct-deposit chargeback in order to recover an overpayment.

Chargeback to merchant - A merchant could receive a chargeback because of making
an unauthorized credit or debit card charge to a customer or a
customer making an unauthorized credit or debit card charge to
someone else's account in order to "pay" for goods or services from
the merchant. It is possible for the chargeback and associated fee
to cause an overdraft or leave insufficient funds to cover a
subsequent withdrawal or debit from the merchant's account that
received the chargeback.

Bank reordering of transactions - The account holder makes a
small debit for which there are sufficient funds in his or her
account. Later, the account holder makes a large debit that
overdraws the account (either accidentally or intentionally). The
bank reorders the transactions and processes the large withdrawal
first, resulting in multiple overdraft fee charges.

Bank fees - The bank charges a fee unexpected to the account
holder, leaving insufficient funds for a subsequent debit from the
same account.

Playing the Float - The account holder makes a debit while
insufficient funds are present in the account believing s/he will
be able to deposit sufficient funds before the debit clears (known
as beat the bank). Many people play the float at one point or
another, but this behavior is also exhibited by those committing
the serious offense of check
kiting. Since the advent of EFT (electronic fund transfers),
playing the float has become increasingly difficult. Some banks may
disable the "debit" option for ATM cards during transactions in the
overdrawn status but allow transactions processed as "credit". Some
other banks however consider it a courtesy to allow debit
transactions in the overdrawn status.

Returned check deposit - The account holder deposits a check or
money order and the deposited item is returned due to NSF,
a closed account, or being discovered to be counterfeit, stolen,
altered, or forged. As a result of the check chargeback and
associated fee, an overdraft results or a subsequent debit which
was reliant on such funds causes one. This could be due to a
deposited item that he knows to be bad, or he could be a victim of
a bad check or a
counterfeit check scam. If the resulting overdraft is too huge
or cannot be covered in a short period of time, the bank could sue
or even press criminal charges.

Intentional Fraud - An ATM deposit with misrepresented funds is
made or a check or money order known to be bad is deposited (see
above) by the account holder, and enough money is debited before
the fraud is discovered to result in an overdraft once the
chargeback is made. The fraud could also be a check
kiting scheme, in which the returned check could leave a huge
criminal overdraft with the account that it is returned to. If the
resulting overdraft is too huge or cannot be covered in a quite
short period of time, the bank will sue or press criminal charges.
The fraud could be perpetrated against one's own account, another
person's account, or an account set up in another person's name by
an identity
thief. If the account belongs to another person or is in his
name, it is said to be "busted out."

Bank Error - Sometimes a bank employee misreads the handwritten
amount on a check, so an amount much larger than the writer
intended to write the check for will actually be removed from the
account. On other occasions, a computer glitch could be responsible
for an overdraft. There are also other types of bank errors which
can work to the account holder's detriment, but others that could
work to his initial benefit. In the latter case, the bank will
correct its own error with the appropriate debit, and if a
resulting overdraft cannot be covered in time, the bank could sue
or press criminal charges.

Victimization - The account has been robbed or cleaned out by a
thief. This could occur as the result of demand-draft, ATM-card, or
debit-card fraud, theft associated with a rigged ATM machine, check
forgery, an "account takeover," or phishing. The criminal act
could cause an overdraft or cause a subsequent debit to cause one.
The money or checks from an ATM deposit could also have been stolen
or the envelope lost or stolen, in which case the victim is often
denied a remedy.

Daylight overdraft - A debit balance in the customer’s
account that occurs in the course of the business day
and is expected to be repaid by a credit to the account prior to
the end of the banking day. Whether this actually results in an
overdraft and the resultant fees depends on the deposit-account
holder agreement with the bank. This may be considered an example
of playing the float, but if the deposit is made available by the
bank before the ledger is balanced at the end of the business day
and the balance remains positive at that time, technically no
overdraft occurs.

Overdraft protection in the United Kingdom

Banks in the UK often offer a basic overdraft
facility, subject to a pre-arranged limit (known as an authorised
overdraft limit). However, whether this is offered free of
interest, subject to an average monthly balance figure or at the
bank's overdraft lending rate varies from bank to bank and may
differ according to the account product held.

When a customer exceeds their authorised
overdraft limit, they go into unauthorised overdraft which often
results in the customer being charged one or more fees, together
with a higher rate of lending on the amount by which they have
exceeded their authorised overdraft limit. The fees charged by
banks can vary.

A customer may also incur a fee if they present
an item which their issuing bank declines for reason of
insufficient funds, that is, the bank elects not to permit the
customer to go into unauthorised overdraft. Again, the level and
nature of such fees varies widely between banks.

In 2006 the Office
of Fair Trading issued a statement which concluded that credit
card issuers were levying penalty charges when customers exceeded
their maximum spend limit and / or made late payments to their
accounts. In the statement, the OFT recommended that credit card
issuers set such fees at a maximum of 12 UK pounds http://news.bbc.co.uk/1/hi/business/4940250.stm.
In the statement, the OFT opined that the fees charged by credit
card issuers were analogous to unauthorised overdraft fees charged
by banks. Many customers who have incurred unauthorised overdraft
fees have used this statement as a springboard to sue their banks
in order to recover the fees. It is currently thought that the
England and Wales county courts are flooded with such claims
http://news.bbc.co.uk/1/hi/business/5187436.stm.
Claimants tend frequently to be assisted by web sites such as
The Consumer Forums
which includes The
Consumer Action Group. To date, many banks do not appear in
court to justify their unauthorised overdraft charging structures
and many customers have recovered such charges in full http://news.bbc.co.uk/1/hi/england/manchester/4810490.stm.
However, there have been cases where the courts have ruled in
favour of the banks and alternatively struck out claims against
customers who have not adequately made a case against their
bank(see
BBC article).

In response to claims by customers to recover
their charges, some banks have closed customer accounts, on the
basis that those accounts have not been operated within the terms
and conditions http://news.bbc.co.uk/1/hi/business/5056882.stm
which the customer consented to when the account was opened.

Overdraft protection in the United States

Overdraft
protection is a financial
service offered by banking
institutions primarily in the United
States. Overdraft or courtesy pay program protection pays items
presented to a customer's account when sufficient funds are not
present to cover the amount of the withdrawal. Overdraft protection
can cover ATM
withdrawals, purchases made with a debit card, electronic
transfers, and checks. In the case of non-preauthorized items such
as checks, or ACH withdrawals, overdraft protection allows for
these items to be paid as opposed to being returned unpaid, or
bouncing. However, ATM withdrawals and purchases made with a debit
or check card are considered preauthorized
and must be paid by the bank when presented, even if this causes an
overdraft.

Ad-hoc coverage of overdrafts

Traditionally, the manager of
a bank would look at the bank's list of overdrafts each day. If the
manager saw that a favored customer had incurred an overdraft, he
had the discretion to pay the overdraft for the customer. Banks
traditionally did not charge for this ad-hoc coverage. However, it
was fully discretionary, and so could not be depended on. With the
advent of large-scale interstate branch banking, traditional ad-hoc
coverage has practically disappeared.

Many banks do now have overdraft departments
which examine overdrawn accounts and decide whether to pay or
return checks and whether or not to charge overdraft fees. The
process is largely automated, but the department also examines
individual accounts on a case-by-case basis.

Overdraft lines of credit

This form of overdraft protection
is a contractual relationship in which the bank promises to pay
overdrafts up to a certain dollar limit. A consumer who wants an
overdraft line of credit must complete and sign an application,
after which the bank checks the consumer's credit and approves or
denies the application. Overdraft lines of credit are loans and
must comply with the Truth
in Lending Act. As with linked accounts, banks typically charge
a nominal fee per overdraft, and also charge interest on the
outstanding balance. Some banks charge a small monthly fee
regardless of whether the line of credit is used. This form of
overdraft protection is available to consumers who meet the
creditworthiness criteria established by the bank for such
accounts. Once the line of credit is established, the available
credit may be visible as part of the customer's available
balance.

Linked accounts

Also referred to as "Overdraft Transfer
Protection", a checking account can be linked to another account,
such as a savings account, or to an existing line of credit such as
a credit card or home equity line of credit. Once the link is
established, when an item is presented to the account that would
result in an overdraft, funds are transferred from the linked
savings account or linked credit account to cover the overdraft. A
nominal fee is usually charged for each overdraft transfer, and if
the linked account is a credit card or other line of credit, the
consumer may be required to pay interest under the terms of that
account.

The main difference between linked accounts and
an overdraft line of credit is that an overdraft line of credit is
typically only usable for overdraft protection. Separate accounts
that are linked for overdraft protection are independent accounts
in their own right; a line of credit is linked solely to the
checking account. Although it is possible to transfer funds from an
overdraft line of credit, it typically requires you to overdraw
your account.

Bounce protection plans

A more recent product being offered
by some banks is called "bounce protection."

Smaller banks offer plans administered by third
party companies which help the banks gain additional fee income.
Larger banks run similar plans, which they usually disclose in
their account opening terms.

Under the plans, the bank may choose to cover
overdrawn items at their discretion and charge an overdraft fee,
the amount of which may or may not be disclosed. As opposed to
traditional ad-hoc coverage, this decision to pay or not pay
overdrawn items is automated and based on objective criteria such
as the customer's average balance, the overdraft history of the
account, the number of accounts the customer holds with the bank,
and the length of time those accounts have been open. However, the
bank does not promise to pay the overdraft even if the automated
criteria are met.

These plans have some superficial similarities to
overdraft lines of credit and ad-hoc coverage of overdrafts, but
tend to operate under different rules. Like an overdraft line of
credit, the balance of the bounce protection plan may be viewable
as part of the customer's available balance, yet the bank reserves
the right to refuse payment of an overdrawn item, as with
traditional ad-hoc coverage. Banks typically charge a one-time fee
for each overdraft paid. A bank may also charge a recurring daily
fee for each day during which the account has a negative
balance.

Critics argue that because funds are advanced to
a consumer and repayment is expected, that bounce protection is a
type of loan. Because banks are not contractually obligated to
cover the overdrafts, "bounce protection" is not regulated by the
Truth
in Lending Act, which prohibits certain deceptive
advertisements and requires disclosure of the terms of loans.
Bounce protection can be added to a consumer's account without his
or her permission, and without informing the consumer.

In May 2005, Regulation DD of the Truth
in Savings Act was amended to require that banks offering
"bounce protection" plans provide certain disclosures to their
customers. These amendments include requirements to disclose the
types of transaction that may cause bounce protection to be
triggered, the fees associated with bounce protection, separate
statement categories to enumerate the number of fees charged, and
restrictions on the marketing of bounce protection programs to
deter misleading advertisements.

Costs

As a source of revenue, banks have the option of
charging a fee for every use. Fees vary widely depending on the
bank and on the kind of overdraft protection used.

Banks process all transactions in the same
manner, so customers can incur these fees even with ATM or debit
card transactions. Compounding the issue, a bank may authorize
transactions in such a way that a single purchase, made with
available funds, can trigger multiple overdraft fees.

Banks collected $17.5 billion in overdraft fees
in 2006; up from $10.3 billion in 2004.

Transaction processing order

The "biggest check first"
policy is common among large U.S. banks, by which items posting to
a customer's account post according to the amount of the item, as
opposed to the transaction time. Banks argue that this is done to
prevent a customer's most important transactions (such as a rent or
mortgage check, or utility payment) from being returned unpaid.
This also has the effect of maximizing fee income since the larger
items deplete the account balance causing multiple overdrafts by
smaller items that present on the same day. Consumers have
attempted to litigate to prevent this practice, arguing that banks
use "biggest check first" to manipulate the order of transactions
to artificially trigger more overdraft fees to collect.

Here is an example of how processing order
affects overdraft costs: A customer has $100 in her account. She
has an outstanding check for $80.00. She buys a cup of coffee for
$1.79 in the morning, buys a $7.00 lunch, and goes to the movies
with a friend, spending another $25. If she checks her balance, it
would show a balance of $66.21 (100-33.79). However, that night,
her check clears, leaving her with a balance of -13.79. With the
highest to lowest processing order, the $80 check would clear
without incurring an overdraft fee, but the remaining 3
transactions would each incur a fee.

Bank representatives claim that the 'biggest
check first' processing order benefits customers as larger
transactions (such as mortgage or car payments, etc) usually have
larger consequences if they bounce (higher interest rates, default
fees, etc). Bank deposit agreements usually provide that the bank
may clear transactions in any order, at the bank's
discretion.

Benefits and risks

If corrected in a timely manner, the
costs of overdraft
protection are typically lower than the fines incurred for bouncing
a check. For a bounced check, the bank will charge the customer a
nonsufficient funds fee (NSF) and the cashing institution will
charge a returned check fee, sometimes in addition to the amount of
the check. This package of fines may be dramatically higher than
the single overdraft protection fee.

For checks, overdraft protection also prevents
the cashing institution from knowing that the person is low on cash
which can serve to protect the customer's reputation.

If the overdrawn state is not corrected within a
short period of time, however, the costs of overdraft protection
increase. If using an overdraft line of credit which isn't paid
back, the interest can accumulate, and in severe cases the line of
credit can be charged off and reported to credit
reporting agencies. A similar scenario can also occur if the
bank charges a daily fee for having an overdrawn account.

The costs of overdraft protection are typically
far higher than the costs of attempting make a purchase with a
debit card or make an ATM withdrawal from an account with
insufficient funds. In the absence of overdraft protection, such
ATM withdrawals and debit purchases may be refused without a fee.
The consumer then may choose to cancel the transaction or to borrow
money from a less-expensive source.

If a US bank account is left overdrawn, after a
minimum number of business days that the account remains overdrawn,
a fee may be assessed for every additional business day that the
account remains overdrawn. Before long, the bank will close the
account unless it is satisfied that the debt is being paid off in a
good-faith manner, refer it for collection, and have its handling
as a negative record against its holder on credit reports and with
ChexSystems.
Reporting of a US account closed due to an overdraft not paid in
time may prevent the opening of an account with another US bank for
five years.

Proposed legislation

H.R. 946, introduced in the US
Congress on February 8, 2007, would increase regulation of
overdraft loan programs. The proposed legislation would Amend the
Truth
in Lending Act (Regulation Z) to clarify that overdraft fees
are covered, require written consent before enrollment in the
overdraft loan program, require financial institutions to warn the
customer when an ATM withdrawal will trigger a fee, and prohibit
financial institutions from changing the order of check clearing or
delaying the posting of deposits solely to increase overdraft
fees.